Question

Companies are required to report liabilities. Identifying unrecorded liabilities could be challenging yet it protects creditors and stakeholders.

1.Define contingent liabilities and the GAAP that governs the reporting or nonreporting?

2. What are your thoughts on the fit or sufficiency of the standard? Is the FASB naive in the expectation of management truthfulness in this area?

Answer 1

1. Contingent liabilities are those liabilities that have possibility of occurring or not occurring i.e. there is a probability of the even happening can have high or low probability.

As per the GAAP principles, contingent liabilities that have a high probability of occurring and the economic outflow is certain, the business must create a provision for it and report in the financial statements.

Contingent liabilities that have medium probability of occurring must be reported in the footnotes of the financial statements so as to let users of financial statements perceive the effects in case the event materializes.

Contingent liabilities that have low probability of occurrence do not have to be reported in the financial statements.

2. The standard is sufficient in cases where the company is reliably able to measure the occurrence or non occurrence of an event. The standard does not sufficiently address the cases that may be a high financial impact but have medium probability. It is difficult to classify such cases and not creating a provision may have a larger financial impact in the long run. The management may although not disclose all contingent liabilities, the audit of the financial statements can assist in correct reporting of the contingent liabilities by the management.